Shipbuilding Contracts: Practical Issues and Considerations

(c) RODNAE Productions

In very recent years, there has been an increase in the number of shipbuilding contracts for the first time following the 2008 financial crisis. Many vessels commissioned around the shipping boom of 2005 are now approaching middle age. The push for greener shipping (along with the incentives that follow) also provide an incentive for companies to invest in newer and greener vessels using new fuel technologies. These factors, among others, have caused a rising market for newbuilds.

In such a rising market, it is not surprising that many yards put forward their standard form of contract and are often unwilling to compromise on the terms. As with any contract negotiation, it is imperative for purchasers to identify the key clauses and tailor a negotiating strategy accordingly to safeguard their interests. This article identifies some of the key clauses in shipbuilding contracts and practical tips in the negotiation of such clauses.

A. Ensuring Performance and Work Quality

More registries are offering incentives to owners through discounts in tonnage fees if the vessel meets such requirements. For example, the Maritime and Port Authority of Singapore administers a Green Ship Programme (GSP) where owners enjoy discounts on the Initial Registration Fees (IRF) and rebates on Annual Tonnage Tax (ATT) payable every year where the vessel uses low-carbon or zero-carbon fuels. Purchasers therefore have a strong interest in ensuring that the vessel achieves the specifications contracted upon with the shipyard.

A shipbuilding contract will contain performance guarantees in relation to, inter alia, speed and fuel consumption. Where the vessel is unable to meet these guarantees, the contract usually provides that the shipyard pays liquidated damages up to a cap at which point the purchaser can terminate the contract or take the vessel at a reduced contract price. However, these remedies may not be feasible or sufficient for the purchaser.

Ideally, purchasers should be satisfied that the shipyard will be able to achieve the performance guarantees prior to execution of the shipbuilding contract. The purchaser should also include opportunities for reviews and inspection within the construction timeline and ensure that it exercises such inspection rights to identify any potential issues so that remedial action can be taken early. The purchaser should also oversee and ensure that the shipyard has sufficient time to prepare the design and engineering before commencement of construction. This also ensures that no issues (whether technical or cost) arise later.

B.Risk of Delays

Generally, most shipbuilding contracts will stipulate a date for the completion and delivery of the vessel. If the shipyard does not meet this date, liquidated damages are usually paid by the shipyard to the purchaser (sometimes after a grace period). The purchaser may terminate the contract once the liquidated damages reaches the cap. However, this may not be desirable for the purchaser in a rising market as doing so may mean that the purchaser would have to wait even longer to secure another vessel at higher prices.

The alternative for the purchaser is to elect to accept delivery at a later date, often with no additional liquidated damages payable. Such delay may also be significant. One way to mitigate the possibility of such delays is for the shipbuilding contract to stipulate payments based on milestones accomplished as opposed to mere dates.

C.Inflationary Pressures

With inflationary pressures being felt worldwide, it is important for the purchaser to ensure that the shipyard does not attempt to pass any rising costs to the purchaser under the guise of “variations” to the agreed scope of work. Shipyards may face rising costs from its suppliers and subcontractors which may only be felt some time into the construction. The purchaser should consider safeguards such as requiring the shipyard to obtain approval for any variations before commencement of such works.

Conclusion

Overall, the market for newbuilds is a crucial aspect of balancing the demand and supply of ships especially in a time when other modes of transport are thriving. Coupled with the push for greener shipping and utilisation of newer and greener technology, we expect to continue to see an increase in orders for newbuilds over the years. It is important for any purchaser to carefully review the terms of the shipbuilding contract to ensure that their interests are safeguarded

 

For further information, please contact:

 

Rafizah Gafoor
Partner
JTJB Singapore Office
E: rafizah@jtjb.com
T: +65 6220 9388